3. Materiality (AU-C 320, 450)

Question 1

Define materiality.

Answer 1

The magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.

Question 2

Determining a materiality level helps the auditor do what 2 things?

Answer 2

1. assess risks of material misstatements and plan the nature, timing and extent of further audit procedures
2. evaluate audit results.

Question 3

Define performance materiality.

Answer 3

The amount(s) set by the auditor at less than materiality for the FS as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the FS as a whole.

Question 4

Define tolerable misstatement.

Answer 4

The application of performance materiality to a particular sampling procedure. It may be the same amount or an amount lower than performance materiality.

Question 5

For purposes of GAAS, the auditor is concerned with fraud that causes a material misstatement in the FS relating to what 2 things?

Answer 5

1. those arising from fraudulent financial reporting

2. those arising from misappropriation of assets

Question 6

What is the difference between fraud and errors?

Answer 6

Fraud is intentional, errors are unintentional.

Question 7

To commit fraud, an individual has what 3 things?

Answer 7

1. incentive or pressure to commit
2. opportunity to commit
3. the ability to rationalized committing the act

Question 8

Name the 3 ways fraudulent financial reporting may be accomplished.

Answer 8

1. manipulation, falsification or alteration of records
2. misrepresentation or omission of events, transactions, etc
3. intentional misapplication of accounting principles

Question 9

Name 4 ways misappropriation of assets may be accomplished.

Answer 9

1. embezzling receipts
2. stealing assets
3. causing an entity to pay for goods and services not received
4. using entity assets for personal use

Question 10

Who is charged with the prevention and detection of fraud?

Answer 10

Governance responsibility and management

Question 11

Name the 4 auditor responsibilities with respect to fraud.

Answer 11

1. Conduct audit in accordance with GaAs and thereby obtain reasonable assurance that the financial statements are free from material misstatement, weather caused by fraud or error
   2 The risk of not detecting a material miss statement from fraud is higher than risk of not detecting an error because frog may involve sophisticated and carefully organize schemes to conceal and or collusion
   3 The risk of the auditor not detecting a material misstatement relating to management fraud is greater than for employee fraud because management is frequently in a position to directly or indirectly manipulate accounting records, present fraudulent financial information, or override control procedures
   4 and auditor must maintain an attitude of professional skepticism throughout the audit

Question 12

What are the 3 objectives of an audit?

Answer 12

1. identify and assess risks of material misstatement of the FS due to fraud
2. obtain sufficient audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate response
3. respond appropriately to fraud or suspected fraud identified during the audit.

Question 13

Define fraud.

Answer 13

An intentional act by one or more individuals among management, those charged with governance, employees or third parties, involving the use of deception that results in misstatement in FS that are subject of an audit.

Question 14

Define fraud risk factors.

Answer 14

Events or conditions that indicate an incentive or pressure to perpetrate fraud, provide an opportunity to commit fraud, or indicate attitudes or rationalizations to justify a fraudulent action;

Question 15

Define professional skepticism.

Answer 15

An attitude that includes a questioning mind, being alert to conditions that may indicate passible misstatement due to fraud or error, and a critical assessment of audit evidence.

Question 16

Define fraudulent financial reporting (cooking the books).

Answer 16

Material misstatement of FS by management with the intent to mislead FS users.

Question 17

Misappropriation of assets (defalcations).

Answer 17

Theft of client assets by an employee or officer of the organization.

Question 18

Risk assessment procedures and related activities. The auditor should perform the following procedures to obtain information for use in identifying the risks of material misstatements due to fraud to include what five things?

Answer 18

1 Make inquiries of management and others within the organization
2 those charged with governance
3 unusual or unexpected relationships identified
4 other information
5 evaluation of fraud risk factors

Question 19

What are the six inquiries and auditor should make of management and others with in the organization?

Answer 19

1 managements assessment of the risk that the financial statements may be materially misstated due to fraud
2 management process for identifying, responding to, and monitoring the risk of fraud
3 management communication, if any, to those charged with governance concerning the risk of fraud
4 management communication, if any, two employees regarding its abuse on business practices and ethical behavior
5 ask management and others with an entity if they have knowledge of actual, suspected, or alleged fraud. If an internal audit function exist, inquire of them to obtain their views about the risks of fraud and determine their knowledge concerning fraud and whether management has satisfactorily responded to any internal auditor findings regarding fraud
6 since management is often in the best position to perpetrate fraud, the auditor may judge it necessary to corroborate their responses

Question 20

Name three inquiries of those charged with governance

Answer 20

1 The inquiries here should be paid of those charged with governance or the audit committee or at least it’s chair of those charged with governance
2 obtain an understanding of how they identify and respond to risks of fraud
3 inquire to determine their views about the risks of fraud and whether they have knowledge of any actual, suspected, or alleged fraud affecting the entity. This inquiry may be made to the audit committee or at least it’s chair

Question 21

What should an auditor consider when unusual or unexpected relationships are found?

Answer 21

Based on analytical procedures performed as a part of risk assessment procedures and as part of substantive procedures, the auditor should evaluate whether unusual or unexpected relationships have been identified. For example, analytical procedures relating to revving you may indicate a possible material on the statement due to fraud

Question 22

What other information shouldn’t auditor inquire about during an audit?

Answer 22

In addition to analytical procedures, other sources include the discussion among team members, information obtained during the client acceptance/retention processes and information from other engagements

Question 23

Name the three valuation of fraud risk factors

Answer 23

1 evaluate whether information obtained from other risk assessment procedures indicate one or more fraud risk factors
2 although fraud risk factors ordinarily do not necessarily indicate the existence of fraud with certainty, they have often been present where fraud has occurred and therefore may indicate risk of material miss statement due to fraud
3 some of these factors will be present in entities where the specific conditions do not present risk of material miss statement. The determination of whether a fraud risk factors should be considered and assessing the risk of material miss statement due to fraud requires the exercise of professional judgment

Question 24

Define professional judgment

Answer 24

The application of relevant training, knowledge, and experience, with in the context provided by auditing, accounting, and ethical standards, and making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement

Question 25

Identification and assessment of the risk of material miss statement due to fraud. Three things

Answer 25

1 The auditor should identify and assess the risks of material misstatements due to fraud at the financial statement level, and at the assertion level for classes of transactions, account balances, and disclosures; this process is ongoing through the audit
2 revenue recognition. The audit should include a presumption that the risk of fraud exists in this area
3 The auditor should treat those assessed risks of material misstatements due to fraud a significant risks and, accordingly, to the extent not already done so, the auditor should obtain an understanding of related controls

Question 26

Name the three responses to the assessed risk of material miss statement due to fraud

Answer 26

1 overall responses
2 audit procedure responsive to assess risk of material miss statement due to fraud at the assertion level
3 audit procedures responsive to risk related to management override of controls

Question 27

In an overall response to fraud name the three overall responses

Answer 27

1 assign personnel with appropriate knowledge, skill and ability
2 evaluate whether the selection and application of accounting principles by the entity, particularly those related to subjective measurements and complex transactions they indicate fraud
3 incorporate an element of unpredictability in this section of the nature, timing, and extent of audit procedures. Examples are performing substance of procedures on accounts not otherwise tested due to materiality or risk, adjust the timing of procedures, use different sampling methods, perform audit procedures at different locations are at locations on an unannounced basis

Question 28

Name 3 audit procedures responsive to assess risks a material misstatements due to fraud at the assertion level

Answer 28

1 nature – may need more reliable and relevant corroborative information. For example, physical observation or inspection of certain assets they become more important or increase external confirmations and include information on terms of sales in addition to balances
2 timing – obtaining information at or near. And maybe more important
3 extent – increased sample sizes or perform analytical procedures at a more detailed level

Question 29

Name the two audit procedures responsive to risk related to management override of controls

Answer 29

1 although the risk of management override of controls will vary from entity to entity, it is present in all entities
2 even if specific risk of material miss statement due to fraud or not identified by the auditor, there is a possibility that management override of controls could occur. Accordingly, the auditor should address that risk apart from any conclusions regarding the existence of more specifically identifiable risk, but designing and perform an audit procedures to test appropriateness of journal entries and review accounting estimates for biases and evaluate whether they circumstances producing the bias, if any, represent a risk of material miss statement due to fraud